taxtales

Thursday, May 17, 2007

1) Because the economy has changed and the Illinois tax structure has not, we run into continual budget crises. Our taxes tend to fall on the manufacturing and retail goods sectors that are declining relative to the whole economy. Tax rates on those sectors are too high and revenue does not keep pace with budget requirements, while the expanding service, financial and information sectors largely escape the existing taxes.

2) The corporate income tax is no longer a tax that can be effectively collected by state revenue departments. Multi-national corporations have become so large and their financial inter-relationships so complicated that it is virtually impossible to monitor the allocation of income to individual states.

David Brunori writes in his 2005 “State Tax Policy”, published by the Urban Institute:

The percentage of total state tax revenue collected from levies on corporate income has declined steadily for more than two decades. … More important, in every year since 1959, the corporate tax base has failed to keep pace with company profits, either worldwide or domestic. In other words, in relative terms, state governments are collecting less in corporate income taxes while corporations are earning more.

Robert Tannenwald, an economist with the Federal Reserve Bank of Boston, writes:

“Multi-jurisdictional entities are so thoroughly integrated that formulas designed to allocate their income geographically are in large part arbitrary and therefore controversial.”

3) The result over time has been a shift in tax burden away from business onto individuals as the response to these changes by state policy makers has been to increase individual income taxes.

Tannenwald’s study showed that between 1986 and 2000 the ratio of state corporation income taxes collected to corporate income decreased by almost 50 percent, while the ratio of state and local personal taxes and charges to personal income increased by 25 percent.

The Solutions:

1) The Governor suggested a gross receipts tax to address all three of the above long term structural problems, make the tax system fairer, and put the state on a sound fiscal basis moving into the future.

2) The only other alternative that has been suggested, SB/HB 750, does not address problems 1 and 2, and makes problem 3 worse.

Monday, May 7, 2007

It is interesting how the opponents of the gross receipts tax have shifted the argument once their first charges proved to be untenable.

Remember the salvos? The GRT will be “devastating to Illinois employers.” “The tax has hurt the economy in every state where it has been implemented.” “It drives businesses out of state.”

We pointed out that there is no evidence to support those charges. Of the three states that have had gross receipts taxes for a long time, Washington, Hawaii and Delaware, the economies in two, Washington and Delaware, have, over the past 20 years, grown faster than the national economies.

And the business leaders in Ohio and Texas supported the gross receipts tax because the existing tax structure no longer fit with the underlying economy. The Ohio Business Roundtable said, “This new tax does not penalize job creation and investment, and also encourages participation in the global marketplace.” The Texas Economic Development Council called the gross receipts tax, “a fair business tax that closes loopholes and provides improvements to the funding for education.”

So we got past the first hurdle. The tax by itself does not devastate the economy.

Now some say we are spinning our tale because we have pointed to Texas and Ohio as examples of states that have recently passed gross receipts taxes. And they explain away the absence of any negative effect from Washington’s gross receipts tax by attributing that state’s economic success to either not having an income tax, or having no competition since it is bordered only by the Pacific, Canada, Oregon and Idaho.

They should just accept the fact that there is no credible evidence that a state gross receipts tax causes the economic sky to fall.

There are a number of legitimate questions. Is the gross receipts tax an appropriate tax to use? Is the overall size of the tax increase reasonable? Will the proposed expenditures be beneficial? Let’s just be clear about which question is being addressed.

Eight states, Washington, Delaware, Hawaii, Kentucky, Texas, Ohio, New Mexico and Arizona, have some form of a gross receipts tax. New Hampshire has a Value Added Tax. All are different, with different rates, different bases, different exemptions. The rest of the tax structure in each of the states is also substantially different. None of that has ever been the issue.

I stand by the arguments I have consistently made.

1) There is no evidence that the gross receipts tax is “devastating” to business.

2) The three states that have recently enacted a gross receipts tax did so largely because existing business taxes did not extend to significant sectors of the economy, and in the cases of Texas and Ohio did so with the support of business groups.

3) In today’s economy, the gross receipts tax is a better option for Illinois than any of the proposed alternatives.

4) Illinois is historically a low tax state, and if the Governor’s proposal is enacted, Illinois will still be in the bottom half of all states in state and local revenues (taxes, fees and interest) collected per $1000 of personal income, and below all but one of our neighboring states.

Thursday, May 3, 2007

I was listening this past week to objections being raised against the gross receipts tax. Two jumped out, mostly because they came from the same person and followed one right after the other.

The first: the gross receipts tax is not related to profitability and will hurt businesses with small profit margins.

The second: we know that it is going to get passed on, just like all other taxes, to consumers and is going to hurt low income families.

I wanted to interrupt, “Choose one … but you can’t have both.”

If profit margins are cut, consumers won’t be affected.

If the tax is passed on to consumers, profit margins won’t be affected.

But logic has never been a necessary ingredient in political discourse.

What do economists know about what happens to taxes on business? Very little really. As William Oakland of Tulane University, and William Testa, vice president of the Federal Reserve Bank in Chicago, wrote in the May, 2000, issue of Economic Development Quarterly, “The actual incidence of business taxes remains unknown …”

There have been lots of studies, but the results depend largely on the assumptions made at the beginning as to how businesses respond to various taxes. It may be that it is this underlying uncertainty that makes the contradictory assertions about the gross receipts tax both believable.

The broad base, the low rate, and the simplicity are the strengths of the gross receipts tax. Because it applies to all economic sectors, the rate can be low. The lower the rate, the more easily it can be incorporated into the cost of doing business. Because the tax affects all economic activity and not just the production of tangible goods, if it is passed on, it is passed on to a much broader range of consumers than those now affected by the sales tax.

The gross receipts tax is better than alternatives that have been suggested to raise the same revenue. Doubling the individual and corporate income taxes would do little to spread the burden of taxes to those who now don’t pay and would simply make those who are paying now, just pay more. Broadening the sales tax to include consumer services would be far more regressive than a gross receipts tax.

Monday, April 30, 2007

The total bite from taxes and fees in Illinois will still be lower than half of the other states. We have the lowest burden of all of our surrounding states, and with the GRT will have the second lowest burden.

Affordable health insurance coverage will make Illinois a more attractive place to live, work and run a business.

Health insurance costs to businesses will be reduced.

With the State assuming a larger role in the funding of schools, the pressures to increase property taxes will be reduced.

The economy of the state of Washington, which has had a GRT for many years at rates similar to those proposed in Illinois, consistently out performs the national economy.

Job growth in Washington last year increased 60 percent faster than in the country as a whole.

The GRT spreads the tax burden more evenly across all business sectors, reducing the upward tax pressure on businesses that pay existing taxes.

The three states that have had a GRT for a number of years, Delaware, Washington and Hawaii, are ranked respectively 9th, 11th, and 24th by the Tax Foundation in its 2007 State Business Tax Climate Index.

In a Washington State Survey, only 8 percent of businesses said that the state’s tax system “had a negative effect on the ability to conduct business.”

A year after the GRT went into effect in Ohio, the Ohio Business Roundtable said, “Unlike the old business taxes, this new tax does not penalize job creation and investment, and also encourages participation in the global marketplace.”

The Texas Association of Manufacturers endorsed the adoption of a GRT in that state, calling the GRT, “a more broad-based, low rate tax structure that is reasonable and taps into the diverse business economy of Texas – ensuring that all businesses do their part in funding education for the future workforce of our state.”

There is no evidence that business is leaving Washington, Delaware, Hawaii, Ohio, Texas, Kentucky, New Mexico, or Arizona, all states that have some form of a gross receipts tax.

Thursday, April 26, 2007

One of the wonderful things about numbers is the games you can play with them. They can be presented in so many different ways that you can tell just about any story you want to and find numbers to back it up.

This is particularly true about percentages. Going from 2 to 4 is a 100% increase. Going from 2 to 6 is a 200% increase. Going from 4 to 6 is only a 50% increase. And going from 6 back to 4 is a 33% decrease. The game is simple. If you want a large percentage to make your point, find a low number to start your comparison. If you want a small percentage to make your point, find a high number. And you don’t have to make up any numbers.

Which brings us to the gross receipts tax that has been called the largest percentage tax increase in any state in the last 10 years.

That is probably true, but true because Illinois starts from a base that is lower than 46 of the other 49 states.

Illinois is a low state when it comes to public expenditures. The latest available data from the Census and the Bureau of Economic Analysis (FY 2004) shows that total state and local government “general revenue from own sources” (which includes taxes, fees and interest, etc.,) in Illinois comes to $14.20 per $100 of personal income, well below $16.08 the mid point of all the states.

If the gross receipts tax is passed, total taxes will increase approximately $1.41 per $100 of personal income, bringing Illinois to $15.71, still in the bottom half of all the states, and below all of our neighboring states except Missouri.

If one is looking at “tax burdens” it is the total in taxes and fees that are paid that makes Illinois more or less competitive with other states. It will be the total that is factored into costs, not just one tax, or two taxes. When all taxes and fees are taken into consideration, even with adoption of the gross receipts tax, Illinois will be competitive.

And what the money will be spent on, an improved education system and universal health care coverage, will make Illinois more attractive as a place to live, to work, and to run a business.

Monday, April 23, 2007

As the opposition witness slips from business groups representing every sector of the Illinois economy were being read off at the Senate Committee hearing on the GRT last week, the thought crossed my mind, “This is the strength of the GRT. Because it is so broad and hits everybody, the rate can be low. Everybody pays a little bit and the burden is spread out.”

If an alternative tax is passed, pity the business sectors that aren’t able to scramble their way out of being hit with that tax, because the rate of any alternative will be much higher than the GRT. Each business sector shouldn’t be thinking how bad the GRT is, but how much worse an alternative might be when they are one of the few sectors being taxed.

In putting out their analysis this week of the economic effects of the GRT, the Realtors used the same assumptions as the Tax Foundation, every business that is part of the production chain passes the entire tax on. Nothing else changes for any business that is not at the end of the line. Then they point to the last business in line and say, wow, look at how much that business is paying! In the Tax Foundation example, one small firm ends up paying the entire tax for 30 larger firms. Not likely!

Of course, we could just tax the last business in line. It is called a sales tax. To match the revenue from the GRT, the state sales tax would have to be raised from 5% to nearly 11%, which would make the combined state and local sales tax rate in Cook County 15.75%. Haven’t heard anyone promoting that plan!

I was in the State of Washington in February. Looked around. Didn’t seem to be any businesses missing! The supermarkets were fantastic. Retail, wholesale, manufacturing, banking, lawyers, all seemed to be present and accounted for.

Costco Wholesale, Microsoft, Washington Mutual, Weyerhaeuser, Paccar, Amazon.com, Nordstrom, Starbucks, Safeco, and Expeditors, all growing their way into the Fortune 500 and all prospering. The Boeing manufacturing plants are still there. The Washington gross receipts tax, in place since 1935, didn’t seem to be chasing anybody away, or causing much of a problem. Jobs in Washington last year grew 62% faster than the national average.

Don’t know how the Tax Foundation explains this one after all the bad things they have said about the Governor’s proposal. Hawaii has had a gross receipts tax (no sales tax) for 30 odd years and also has a relatively high personal income tax and very low property taxes. In commenting on Hawaii’s tax structure in its 2007 report on state business tax climates, the Tax Foundation wrote, “Hawaii’s overall rank, 24th best, would be much higher if the state could reform its individual income tax without causing damage elsewhere in what is otherwise a good tax system.” Most of the “otherwise” part is a gross receipts tax.

My good friend Tom Johnson, of the Taxpayers Federation, twice this week at public forums quoted an article saying only 16% of state services benefit business, and wanted to know if it was fair to ask business to pay more than 16% of the taxes. I read the article and looked at how the author allocated benefits. I would ask Tom these questions: Does business really get no benefit at all from our community colleges or universities? Would a business locate in a state with no schools? Does business benefit from the state paying the heath care costs of low wage workers that don’t get health benefits from work? How much would highway costs go down if there were only cars and no fully loaded 18-wheelers pounding the concrete?

Probably the most useful thing I have learned in 30 years as a professional economist: if you want to understand the numbers that come out at the end of a study, look at the assumptions made at the beginning of the study.

Thursday, April 12, 2007

It is somewhat amusing to listen to groups representing multi-national corporations attack the gross receipts tax because it will hurt small businesses, discourage individual entrepreneurs, and be paid eventually by working families.

It reminds me of the debate on the inheritance tax when I was a member of the House of Representatives. My memory may not have the numbers exactly right but the argument being made against the tax went something like this: widows who didn’t know how they were going to pay for their next meal needed protection from a tax that exempted the first $650,000.

It is kind of the big guys to be so protective of the little guys, but one wonders what the facts are. Here are some to keep in mind.

The purpose of Governor Blagovejich’s proposal is to reduce the reliance of schools on the property tax and to extend health care coverage to working families that aren’t being covered by their employers and can’t afford to pay for it out of their wages. Without new revenue those goals will not be achieved.

Without question, the property tax is the most difficult tax for new and small businesses to pay.

Under any set of assumptions, working families will pay a smaller share of the gross receipts tax than any other alternative proposal that is being made.

The broad base and the low rate of the gross receipts tax, compared to other taxes, means that it will be spread more evenly and more fairly across all business sectors. The gross receipts tax is also simple and straightforward so it is not as subject to accounting manipulations as the corporate income tax, and is more difficult for multi-national corporations to avoid.

The Tax Foundation, out of Washington, DC, and aligned with big business, has expressed grave concern over the Illinois gross receipts tax. It has a marvelous example of a “hypothetical” small manufacturing company that somehow has its profits reduced by $10,000 as a result of the gross receipts tax even though it is too small to be subject to the tax. It seems that this small company has 30 suppliers all of whom are large enough to be subject to the tax, but none of whom pay any of the tax. Neither the sales or the profits of the 30 large companies are reduced by the tax, because they all pass the tax on to the one small company at the end of the production chain that ends up in the “hypothetical” example paying the tax for all 31 companies.

The small company is put out front like the poor widow, both to divert our attention and draw our sympathy. But even in the Tax Foundation’s fictional account the one small company has a problem only because 30 large companies pass all their tax liabilities onto its narrow shoulders. How real is that “example”? We are supposed to believe that 30 companies large enough to be subject to the tax, don’t pay anything, while one small company, small enough to be exempt from the tax, has to pay the tax for all of them.

Everyone should have a friend like the Tax Foundation looking out for them!

What are the alternatives to the gross receipts tax being suggested by those who want to protect working families? A 5 percent tax on among other things, hair cuts, funerals, doing the laundry, and home repairs, and an increase in the personal income tax from 3% to 5%. Somehow those taxes are “better” for working families than the gross receipts tax.

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About Me

Douglas is an economist and President of Program Analysis Inc., a consulting firm that specializes in economic and public policy issues. He is a former Illinois state representative who represented Springfield from 1974-1982. One of his current clients is the Office of Management and Budget of the State of Illinois that sought his help with the economic effects of the gross receipts tax.